Moving on – Australian shares and the Federal election

10:10, June 28th 2016

· by Michael McCarthy

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Which brings us back to Australia. In case you dozed off during this long campaign, the Federal election is this Saturday. At CMC we have developed the Election Sentiment Index (ESI) to track the impact of the campaign on market sentiment.

"Brexit could be followed by Grexit, Departugal, Italeave, Czechout, Oustria, Finish, Slovakout, Latervia, Byegium. Only Remania will stay.”

This tweet from last Friday neatly summarises the main concerns from a Brexit, from an investors’ point of view. There is no “credit event” here, the root cause of the GFC. There is little or no threat to the global banking system.

However, there are implications for global growth. A drag on growth in both the UK and Europe is likely. This is important because the European Union is still the second largest economy in the world. Bad news, but not a catastrophe. The potential for others to follow and break apart the EU is the biggest risk. This seems unlikely but can’t be ruled out. No doubt news flow from Europe will have investors and markets jumpy, but the potential for a chaotic break-up of the Union seems low at this point.

Which brings us back to Australia. In case you dozed off during this long campaign, the Federal election is this Saturday. At CMC we have developed the Election Sentiment Index (ESI) to track the impact of the campaign on market sentiment.

The ESI examines the performance of the Australian share market. It takes the daily performance of the Australian share market, and strips away performance drivers such as global stock sentiment and commodity price moves. In stripping market factors, the ESI singles out the impact of shifting political currents on Australian market thinking.

Politicians have a tendency to overestimate their contribution to economic performance, especially when things are going well. Government policy and the economic structures it create are an important influence on the economy, but there are many other factors that drive economies over which politicians have little or no sway. Nevertheless, the changes to policy flagged by hopeful parties and candidates can impact share prices.

When the ESI moves higher, Australian investor sentiment, as measured by the share market, is improving. Conversely, negative moves for the ESI suggest the election campaign is weighing on stocks. The ESI (above) is painting a fairly ugly picture.

The initial investor enthusiasm at the announcement of the election soon gave way to a clear down trend. There are periods of solid gain, but the overall impact measured by the ESI is negative.

Weighing on sentiment are announced policies that target banks for reform, break up or interrogation. With financial stocks comprising around half of the value of the share market, it remains a sector highly sensitive to policy announcements.

Superannuation policy remains a focus, as it will hit investor sentiment both directly via the banks and fund managers, and indirectly via the activities of SMSF investors in light of any changes

Interestingly, the ESI responds to periods of little campaign news flow with gains, confirming that as far as markets are concerned no political news is good news.

Perhaps the most important factor is the prospect of another hung parliament. If no party gains a clear majority in the Senate the ability of the new government to implement its agenda is curtailed. Such a “weak executive” puts much needed structural reform of Australia’s economy at risk. Polls repeatedly show the major parties within a few percentage points of each other, and minor parties making clear inroads. The fall in the ESI suggests investors are pricing three more years of argy-bargy and horse-trading in Canberra.

However, the ESI jumped after the LNP and Green Party launch on Sunday past. Naturally, the LNP is considered more business friendly than the Greens, and the surge in the index may reflect a view that the LNP are on track for a majority, potentially at the expense of the minor party.